Quality of street earnings improves when data providers limit analysts’ discretion, study finds
LAWRENCE — When a news article reports whether a company’s earnings met analysts’ estimates, the numbers are usually based on “street earnings” information sourced from forecast data providers such as Bloomberg or Thomson Reuters.
However, a new study by Eric Weisbrod, assistant professor of accounting at the University of Kansas School of Business, examined what happened when one such provider discontinued its practice of relying on analysts for certain decisions. It shows this change led to street earnings more predictive of future performance.
“The Roles of Data Providers and Analysts in the Production, Dissemination, and Pricing of Street Earnings” appears in the Journal of Accounting Research.
“Markets are becoming more data-driven all the time. Our goal is to better understand the role of data providers in modern capital markets,” Weisbrod said.
“In this study, we use a natural experiment to isolate the effect of data providers because street earnings can be jointly influenced by data providers, analysts and the company’s management.”
Co-written with Khrystyna Bochkay of the University of Miami, Stan Markov of the University of Texas at Dallas and Musa Subasi of the University of Maryland, Weisbrod’s research examines how, in 2009, Thomson Reuters stopped relying on analysts to determine the treatment of unexpected charges and gains in favor of their immediate exclusion from GAAP (generally accepted accounting principles) earnings.
“The methodology change improved the timeliness and quality of Thomson’s street earnings data, making more predictive of future performance,” Weisbrod said. “Accordingly, investors increased their reliance on the data, and analysts also changed their treatment of unexpected line items to be more similar to Thomson Reuters.”
As a metaphor to describe the methodology adjustment, Weisbrod said it’s comparable to what would happen if baseball umpires changed the way they kept score during a game, following their own discretion.
“People often assume analysts know the best earnings adjustments to make and that data providers are simply a conduit to transmit information between analysts and investors. But we find when the data provider removes analysts’ discretion and follows a simple rule to always exclude unexpected items, it actually improves the predictive value and quality of the information,” he said.
Incentives also factor into such decisions.
“Even though analysts are professionals and are trying to predict future performance, they also have to curry favor with management and generate trading volume for their brokerages,” he said. “Given these incentives, our findings suggest street earnings information actually improves when you take some decisions out of analysts’ hands and let the data provider decide in a more uniform way.”
Weisbrod’s research indicates that data providers are constantly evolving. For instance, they are increasingly tracking non-financial information known as key performance indicators (KPIs). What were the company’s carbon emissions? How many revenue passenger miles were flown this quarter?
“Analysts are beginning to forecast these KPIs,” he said. “But there are no steadfast rules on exactly how to measure carbon emissions and other non-financial data. So to some degree, data providers serve as referees in determining how to standardize these items.”
In 2016, Weisbrod moved to Washington, D.C., to serve as an academic fellow in the Office of the Chief Accountant at the U.S. Securities and Exchange Commission. During that time, the SEC was clamping down on how companies discussed non-GAAP numbers in their earnings press releases to ensure they were not misleading. At the same time, the Chief Accountant’s office also began taking an interest in how third parties were presenting companies’ financial info online. These experiences motivated his research on this topic.
The Dallas native came to KU in 2020, where his field of study focuses on financial data providers and financial analysts.
“As markets become more data-driven, and as investors start weighing additional measures in their investment decisions — whether it’s governance, sustainability or non-financial performance — people should take care to look at who’s providing the data,” he said.
“What are their incentives? Are there any rules in how they’re giving you this information? You always want to make sure you’re not being manipulated.”